Greece negotiates with the International Monetary Fund (oh and the European Commission and the European Central Bank)

Last week turned out to be quite a significant one in several respects. We saw for the first time a euro zone country in such a state of distress that she had to ask for help. The Greek Prime Minister Mr. Papandreou gave a dignified speech but the cry of “help” will have resonated around the world. It will have reminded everyone that the constitution of the Euro had two rather large flaws namely that it was constructed with neither political union nor co-ordination of fiscal policy.Indeed the planners of Europe had made grand claims for economic convergence whereas in fact we have had economic divergence. In that sense it is hard to think of a scenario which would have proved them more in error.

The IMF

The week was also significant for the International Monetary Fund which finds itself thrust into the firing zone of European Union politics. As I have written before it is used to having primacy and control when it intervenes to help a country which is in crisis. I have also previously pointed out that its original role was to help countries with balance of payments problems. Now whilst Greece does have a balance of payments problem her real problem is a fiscal deficit so the role of the IMF is morphing from its original objective to become a type of fiscal deficit policeman. No wonder the G20 authorised a US $ 500 billion increase in the loan capital of the IMF which came into effect on April 12th this year. So the IMF has in effect a new role and expanded capital to do it but in this instance she also has to deal with the European Central Bank and the European Commission. So this issue is a big challenge for the IMF and its role.

There is one further ingredient to the mix. The President of the IMF Mr. Strauss-Kahn is widely believed to have political ambitions in France probably for the Socialist Party there. So it is not inconceivable that he will try to meddle with the plans of IMF negotiators and officials for Greece. It would certainly suit him to have a “success” , so a scenario which has suffered from political meddling may well get another dose of it.

A Question for you

I have a question for my readers here and it relates to the recent increase in loan capital for the IMF. This was announced to great fanfare at the April 2009 G20 meeting by the UK Prime Minister Gordon Brown. He announced it as if it was a rabbit from a hat. However there are potential implication from it, for example what would happen if some of the money was lent and the loan was not repaid? Who is then liable? Has there in any country been a debate on this? As the largest player the biggest potential burden is on the taxpayers of the United States but all G20 countries are involved and liable. This strikes me as an off-balance sheet liability for the taxpayers of the G20 nations.

Before this capital increase which came into effect various nations made bilateral loans.We in the UK had a bilateral agreement to loan $15 billion if necessary since last September as a lead into this. I read the agreement and noticed that it was set up as a recurring one year deal which immediately triggered a thought at the back of my mind that such a term might be sufficient to stop it going into the national accounts. This leaves me with the view that this latest more formal increase in loan capital may not have a corresponding debit anywhere in the world’s accounts…….

Greece

There is a lot of debate going on in Greece as to what is the best course of action will be. There is clearly fear in the air as to what terms may be imposed by the IMF on her. Indeed even the man who called for aid her Prime Minister said that Greece would now see “a partial surrender of sovereignty”. However the truth is that she had no choice as she had lost any semblance of control over her debt markets and it would have been much better if she had made the decision earlier when yields were lower. Whilst I have sympathy for the situation the current government found itself in I have much less sympathy for the way that her government has dithered and vacillated. However I have no sympathy at all for the opposition New Democracy Party the previous Greek government which has had the cheek to accuse the current government of creating the crisis. This is a shameful effort to rewrite history and avoid the implications of ita own actions.

On Friday Greece’s ten-year bond yield closed at 8.73% and remember this was after an announcement of officially calling for aid. This time the rally from an official announcement lasted about 3 hours at most and the story of the boy who cried wolf comes to mind when I think of the number of times politicians have claimed to have “saved” her. She has a three-year bond which closed at 10.64% and I quote this because I suspect this yield might be quoted in the German Constitutional Court as time goes by, as the proposed loans at 5% from Europe will have a three-year term and will be at a rate at less than half of market rates when the aid plan was called for.

What is happening right now?

Leaks from the negotiations are suggesting that the European Commission is taking the lead (IMF primacy anyone?) and it is marching to a German inspired tune. This would involve an austerity plan for next year equivalent to the one already imposed by the current Greek government for this year. So Greece must come up with a detailed programme for cutting the budget next year by a further 4 %  of her  gross domestic product (GDP).Let nobody be in any doubt that if you look at historical comparison this will be a severe squeeze.

Comment

Whilst Mr. Strauss-Kahn may be pleased at avoiding being  a public bogeyman for the sake of his future political ambitions this is not a good development as the IMF should be in charge. Also whilst it is a good sign that 2011 and hopefully 2012 are being addressed in some form the aid package will have to include money for those years too and at this time it does not. Greece will have to borrow heavily in 2011 and 2012 and if it is to work this aid package will have to have the ability to cover these years too.

What needs to happen?

1. The potential size of the loans available to Greece need to be substantially increased. The current amount is not enough and I would treble it as Greece will need help in 2011 and 2012. I would hope that it would not need to be fully used and that circumstances might improve but now is a time for a contingency fund that covers pretty much anything and everything. Because of the dithering that has gone on we now need a decisive move to try to retake the initiative.

2. Greece needs to present a three-year programme that involves a combination of specified expenditure cuts and also plans for structural reform. In essence the objective needs to change to attempting to achieve a balanced budget by the end of the three-year term so that Greece can then finance herself.

3. European and Greek politicians have so far disappointed  and they have made a difficult situation worse. They need to realise that this is a national emergency and get a grip on both events and reality.

4. Greece should begin now negotiations for a technical default or “haircut” on her existing debts. I have argued previously for a 15% haircut but because of the deteriorating situation I feel that this now needs to be 20%.

This adjustment will be painful and there is no guarantee of success as there is a danger of a downward spiral where recession leads to depression for Greece. Whilst there are differences in the situation between Greece and Latvia those interested in the scale of the likely impact on Greece might like to look at my update of the 12th March.

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15 thoughts on “Greece negotiates with the International Monetary Fund (oh and the European Commission and the European Central Bank)

  1. The IMF is in danger of becoming the last bubble within the bubble supporting the inverted pyramid.

    It strikes me as an last ditch attempt by Western Governments to put off the eventual reckoning with China.At some point there needs to be a mechanism for the transfer of $’s held in China back to negate Western deficits.The price will not be monetary, it will be in physical resources and geopolitical influence?

    Welcome to the Chinese century.

  2. If the EU/IMF demands a grinding depression like Latvia’s, I have severe doubts the Greek people will simply roll over and accept this. By the end of 2011, there will be a “negotiated default” whereby Greece will refuse to pay it’s foreign creditors until it’s economy recovers and even then it’ll be something like ten cents on the dollar. The worst part is, this will not solve Greece’s problems; the depression will go on for years to come. Lets just hope that the CDS problem has been solved when this happens or we will have Lehman 2.0

  3. Another great post Shaun. Do you think this has big implications for UK and UK based assets such as House prices or sterling bank accounts? Gold price will surely go up from here to fresh highs.

  4. To attempt to answer your question posed here to contributors, Shaun, I think your implication is correct; this levy has already become yet another off-balance sheet liablity, and will increase presumably on a rolling basis year by year. This is yet another growing off-balance sheet liability which the UK has incurred, to add to all of the others.

    I personally suspect that generally we are now completely unaware of the total amount of these off-balance sheet liabilities now within our total Public debt; I suspect the government is not coming clean on this, for obvious reasons, and the total amount of debt with all of these liabilities added is much greater than commonly realised. If you think back just on those items of expenditure which have been publicly announced as being added to the off-balance sheet liabilities, there are now so many that with the interest due, this aggregate amount added to the other overt debt now reaches a truly staggering amount. This all has to be debt serviced in the future and eventually repaid. A quite frightening prospect. I have a feeling that this could be an aggregate of as much as £4 trillion?

  5. I’ve been reading your blog for a while now, so I feel I “owe” you a comment….

    The point about accounting for the IMF’s capital is interesting. Strictly speaking if the UK loans the IMF some funds then that should count as an ASSET for the UK and a LIABILITY for the IMF/Greece. That’s how banks do their accounts: customer deposits are liabilities while outstanding loans are assets. Having the same money counted on the national debt of two different countries at the same time would seem perverse. The UK position should be that the debt is exactly offset by the asset of the loan.

    And yet, as you say, if the loan goes bad, it can very quickly stop being an asset.

  6. Nationalist:”The point about accounting for the IMF’s capital is interesting. Strictly speaking if the UK loans the IMF some funds then that should count as an ASSET for the UK and a LIABILITY for the IMF/Greece. ”

    Indeed, but the money will have to be borrowed (or printed) in order to lend it to Greece. So we have a potential liability, and a potential borrowing requirement.

    Also, if the loan is a soft one, then surely the market value of that loan would be less than the face value, thus the liability would be greater than the asset. I think.

  7. Thank you for an interesting post Shaun,
    I have a couple of comments regarding Greece. One is the large size of the “informal” economy, which is in the order of 25-30%. Because of this, a large section of the population doesn’t really care about government debt and default. Life will go on, and is very much going on — the taverns and bars are still very much crowded in Greece I am told, you cannot find a place when you go out in the evening. The other has to do with political stability (as MrK has hinted), which in Greece has been achieved with the allocation of government jobs and perks (paid for with borrowed money). This has been going on at least since the end of the civil war in 1949 — and even from the interwar period. The state sector and state-guaranteed benefits have grown to be humungous, but this is what has kept the peace (emigration was another outlet in the distant past).
    It has also been politically difficult to crack down on tax-evaders, and this is where the IMF might actually provide some help (technical assistance and political cover). Per the Greek press they have already made specific recommendations on how to improve tax collection (what collection?)– and this might go a long way toward improving the budget. It is interesting that all Greek political parties are villifying the IMF, but do not have any suggestions on how to do something about the problems as it is politically too costly.

    js

    • Good points,
      The bet I think is if Greece will manage to diminish the informal economy and release the formal and healthy economy. Greek government has to prove that it can achieve this. IMF involvement is critical to aid technically. I do hope that Greece will be one of the success stories for IMF.

    • Hi John
      Thanks for the reference to the BarCap report. I think that if you look at their analysis they are looking at the ultra long term with an objective for the year 2050. Apart from the obvious point that such a long time scale is a sign of the scale of Greece’s problems I think that there are two problems with looking at it in this way.

      1. Any analysis of this type of such a long time period depends for its results mostly on economic growth rather than the fiscal adjustments and haircuts they discuss, hopefully by 2050 both will be long forgotten! Economic growth is likely to be the largest factor and over such a period who really has much idea of what it will be? In a period of such interest rate volatility I would also like to know what their interest rate assumptions were. The higher the interest rate the more valuable a haircut is.

      2. Greece’s problems are in my view much shorter-term as again in my view her priority is to be able to get through the next 5 years and over such a time period I think the results of a haircut would be different. In essence a 20% haircut of the type I suggested today would reduce Greece’s debt servicing costs by that amount and over the next five difficult years that will help her a lot.

      In a way the answer you get depends in economics on the question you have asked and I am not sure that they have asked the right one… I think that the difference between them and me is that I feel the priority is now and the reasonably immediate future and they seem to think 2050 is important. One such type of long-term analysis completed in Victorian times projected that London would be six feet high in horse dung in 40 /50 years if I recall correctly. It is a little twee as an example but it is not a cheap shot as the longer the time period you look at the more important the assumptions you make become (and I would add the more likely they are to turn out to be wrong).

      However you also posed the question what will my plan achieve? I feel that it will maximise the chance of a successful transition for Greece towards a stable deficit because the austerity required is going to be very painful and there is bound to be unrest. I feel that adding a haircut will not only help reduce the cost of Greece’s debt but will help in the psychological battle of Greece accepting the pain in a form of “foreigners and speculators” taking some pain too.

      So with my logic it is better for Greece to have a “haircut” now (otherwise you run the danger of imposing it on the EU loans etc) as if you are going to do it the sooner the better. But I do not want the debate over it to obscure the fact that the main player in Greece’s future will be her willingness and ability to reform combined with an austerity plan and here I think the authors and I are in agreement . Any foreign aid and any haircut are if you like assistants to help the main show. Personally I think that without aid and a haircut the austerity plan is likely to fail.

  8. In regard to the Greece black economy. I can imagine Germany and other Euro partners pushing hard to find and employ tools to actually tax the tax evadors. Maybe even use some of the new banking tools to track money bleeding from Greece banks. Or use the Scandinavian model were all income of publicly employed people is open for everybody to see. For the other Euro members this is a popular measure and one which could greatly improve the current situation. If the numbers are correct the potential increase in government revenue is somewhere around 20%. Which is a lot. Given that the other club med countries also have a very large black market which potentially can be tapt for tax revenue it is there were they might find the money they need to get out of this mess.

    • Uhm, on another note. Some colleagues here in California are telling me they got their tax return as an IOU from the state. If CA can print IOUs why cant Greece do this to her populous? Might help to virtually introduce some money printing in the system. Just a thought.

  9. issuing IOU’s in an interesting concept.The Greek population would be directly exposed to the creditworthiness of the nation.Would therefore it assist the population in acceptng that the need for economic reform is in their own interests?

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